Question

Alex Meir recently won a lottery and has the option of receiving one of the following three prizes: (1) $96,000 cash immediately, (2) $39,000 cash immediately and a six-period annuity of $9,800 beginning one year from today, or (3) a six-period annuity of $18,800 beginning one year from today. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) 1. Assuming an interest rate of 5%, determine the present value for the above options. Which option should Alex choose

Answer 1

Answer: Option 1

Explanation:

The option selected should be the one with the highest present value.

1. Present value = $96,000

2. Present value = $39,000 + Present value of $9,800 annuity

Present value of Annuity = Annuity * Present value interest factor of annuity, 6 periods, 5%

= 9,800 * 5.0757

= $49,741.86

Present value of option 2 = 39,000 + 49,741.86

= $88,741.86

3. Present value of $18,800 annuity:

= 18,800 * Present value interest factor of annuity, 6 periods, 5%

= 18,800 * 5.0757

= $95,423.16

Cash payment of $96,000 immediately is best option as it is highest.